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A Gucci Bubble Gets Pricked by the Trade War

(Bloomberg Opinion) -- Throughout the seemingly endless U.S./China trade war, shoppers from Shanghai to Beijing have been serenely snapping up luxury goods, from Gucci logo T-shirts to Balenciaga sneakers and Cartier nail bracelets.

That could be about to change. The rhetoric and actions of presidents Donald Trump and Xi Jinping seem to have entered a new phase, and the strong first quarter sales from the likes of LVMH and Kering SA could prove a last hurrah before the escalating trade spat takes its toll.

On Friday, Cie Financiere Richemont SA was the latest group to say that Chinese demand proved resilient to the threats: sales on the mainland rose by a percentage in the double digits over the year to March 31. Purchases by the travelling Chinese luxury consumer were slightly lower, expanding in the high single digits.

The biggest buyers of luxury goods in the world have turbocharged the industry for the past three years. Some of that was pent up demand from 2015 and early 2016 when terrorist attacks on Paris, falling stock markets and a crackdown on extravagance prompted Chinese shoppers to rein in spending.

That elevated level of consumption was never going to last. The only question was whether the slowdown was going to be a gradual decline or an abrupt stop.

Even against the backdrop of trade tensions since last year, big groups continued to report decent Chinese demand, and that made it look as if a soft landing was on its way. That was helped by reductions in duties on luxury goods purchased domestically, which made them more affordable to buy at home, as Richemont noted on Friday.

But over the past few weeks, several factors have raised the risk of a worse outcome.

Although luxury goods aren’t included in the list of U.S. products facing higher tariffs so far, the danger is from second order effects, primarily that the trade war damages growth or Chinese consumer confidence, and in turn, sales.

And the Chinese economy is fragile. Industrial output, retail sales and investment all slowed more than economists forecast in April. It’s not clear whether rising house prices and extra liquidity from the People’s Bank of China can be enough to stem a decline in sentiment.

But the backdrop for consumers is unhelpful even before the U.S. raises additional tariffs on $200 billion of Chinese imports to 25% from 10%. Earlier this year, shoppers were already restricting purchases of items such as smartphones even as they snap up Gucci loafers, as my colleague Shuli Ren points out. Now, it’s hard to see how luxury goods can completely avoid going the way of the iPhone in China.

It doesn’t help that luxury shopping sprees abroad are getting more expensive. The drop in the yuan against the euro and dollar is bad news for European and U.S. luxury groups who benefit when travelling Chinese consumers stock up on Hermes scarves in Paris or Tiffany pendants in New York.

The hardening in the stance of both sides in the trade war has just raised the risk that Chinese shoppers really close their wallet. Stock markets are taking last week’s volleys seriously, with declines on Friday as Chinese state media appeared to signal a tougher line.

Luxury stocks sold off last year when the trade tensions emerged, but the reaction to the most recent hostilities has been modest. Although the Bloomberg Intelligence index of top luxury companies weakened in May, it is still up from the start of this year.

This could be a sign of complacency. As Mario Ortelli, managing partner of luxury adviser Ortelli & Co points out, the business of high end goods is one of happiness. Buying a Chanel handbag in Paris, or even taking that trip to Europe in the first place, is more likely when consumers feel rich and not beset by worries. So anything that undermines that confidence is a concern.

It is not yet clear how the trade war will play out. We've been here before, only to pull back from the brink, and for shoppers to carry on regardless. But if the situation continues to worsen, there is less chance of those Gucci T-shirts escaping the fallout.

To contact the author of this story: Andrea Felsted at afelsted@bloomberg.net

To contact the editor responsible for this story: Jennifer Ryan at jryan13@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Andrea Felsted is a Bloomberg Opinion columnist covering the consumer and retail industries. She previously worked at the Financial Times.